Undisclosed Reserves: What They Are and How They Work
Undisclosed reserves are real capital items that a bank holds on its books but does not present in public financial statements such as the balance sheet. They typically arise through internal provisions or charges to profit and loss (P&L) that reduce reported earnings or retained earnings, creating a hidden cushion that supervisors may recognize as supplemental capital.
Key points
- Undisclosed reserves exist on a bank’s internal records but are not shown in published financial statements.
- They are generally treated as part of Tier 2 (supplementary) capital rather than Tier 1 (core) capital.
- Acceptance of undisclosed reserves varies by jurisdiction; some regulators recognize them, others do not.
- Tier 2 capital is less liquid and considered a weaker loss-absorbing buffer than Tier 1.
How undisclosed reserves fit into bank capital
Bank regulatory capital is commonly separated into:
* Tier 1 (core capital): equity capital and disclosed reserves (e.g., retained earnings). It is the primary, most liquid buffer against losses.
* Tier 2 (supplementary capital): less liquid items that supplement Tier 1.
Explore More Resources
Undisclosed reserves are counted among Tier 2 components. Typical items included in Tier 2 calculations are:
* Undisclosed reserves
* Revaluation reserves
* General loan-loss reserves
* Hybrid debt–equity instruments
* Subordinated term debt
Under Basel-based frameworks, Tier 2 is limited relative to Tier 1 (commonly capped at 100% of Tier 1), so undisclosed reserves contribute to but cannot exceed regulatory bounds on supplementary capital.
Explore More Resources
Practical and regulatory considerations
- Prevalence: Undisclosed reserves are relatively uncommon in modern practice but may be accepted by some supervisory authorities when a bank has earned profits that haven’t been reflected in disclosed retained earnings.
- Jurisdictional differences: Some countries’ accounting and regulatory frameworks do not recognize undisclosed reserves as legitimate capital.
- Liquidity and stress: Because Tier 2 capital is less liquid and less reliable in crisis conditions, undisclosed reserves are viewed as a weaker form of protection than Tier 1. Post-2008 stress tests and regulatory reforms increased scrutiny of capital quality.
- Transparency: The hidden nature of undisclosed reserves reduces public transparency and can complicate external assessments of a bank’s financial strength.
Implications for stakeholders
- Regulators: May accept undisclosed reserves in limited circumstances, but emphasis is on higher-quality, disclosed capital.
- Investors and counterparties: Should be cautious relying on undisclosed reserves as evidence of strength because they are not visible in published accounts and may not be recognized uniformly.
- Banks: May use undisclosed reserves as a supplementary buffer, but face limits on recognition and potential skepticism from markets.
Bottom line
Undisclosed reserves are hidden capital items that can bolster a bank’s supplementary (Tier 2) capital but are less liquid and less universally accepted than disclosed Tier 1 capital. Their treatment depends on local regulation and supervisory practice, and they offer limited comfort compared with transparent, high-quality capital in times of stress.